8/21/2009 @ 5:40PM

The Little Engine That Couldn't

The utility industry has seen the economic downturn pull the plug on electricity demand, with a turnaround not expected until the next year or two. (See “Utility Sector Low On Power.”) Coal, which is used to produce electricity, has been piling up–so much so that utilities’ stockpiles of the combustible mineral are the highest they’ve been since 1991, according to Citi analyst Matthew Troy, who said it’s unlikely that the raw material will see a demand spike anytime soon.

“While coal management teams have highlighted take or pay utility contracts as providing a floor to volumes in the second half of the year, unwanted deliveries delay the inevitable by driving stockpiles higher, likely muting a recovery as consumption trends normalize in 2010,” Troy said.

Last week, the Energy Information Administration reduced its forecast for annual coal demand from power generators to 975 million tons, which was 12 million tons lower than the previous month’s forecast, and coal producers are scrambling to realign production levels with dismal demand.
Arch Coal
slashed its output target for the third time this year when it reported a second-quarter loss at the end of July.

Although the company expects power demand to stabilize deeper into 2009, it couldn’t rule out additional production cuts in 2009 and estimated that domestic coal production will drop by more than 100 million tons this year. On the heels of Arch’s dismal report,
Patriot Coal
announced the closing of its surface mine in southern West Virginia. The company said that the challenging coal market is forcing the company to focus on low-cost mining options.

The rail industry is another sector getting burned by weak electricity trends since coal comprises as much as 30% of the rail industry’s volumes, Troy said. Coal volumes fell by 13% in the second quarter after holding up relatively well–down by only 5% in the first quarter–and aren’t improving with volumes already off by 11% to 12% in the current quarter.

A light at the end of the tunnel could come from China.
Consul Energy
recently announced a deal to export U.S. coal to China and Troy said talk in the industry suggests that China may be looking to the U.S. for some of its sedimentary rocks needs as population growth puts pressure on its resources.